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Summary Fallen angels have been flying steady amid the recent high-yield turbulence. There is a major difference between low-quality and high-quality junk bonds. The BB-focused ANGL has outperformed three much more popular other high-yield ETFs. I believe that this Morningstar 5 star-rated ETF deserves much more attention from the Seeking Alpha community. Introduction (Source: Villains Wiki ) The Market Vectors Fallen Angel Bond ETF (NYSEARCA: ANGL ) tracks the BofA Merrill Lynch US Fallen Angel High Yield Index (H0FA). This index is comprised of below-investment grade (“junk”) corporate bonds that were rated investment grade at the time of issuance. All bonds are denominated in U.S. dollars and are issued in the U.S. domestic market. Earlier this year, I provided an introduction to ANGL in the article ” Harvesting Higher Yields With The Fallen Angel Bond ETF “. The article gave information as to the credit composition, historical performance and other statistics regarding ANGL compared to two junk bond ETFs, the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) and the SPDR Barclays High Yield Bond ETF (NYSEARCA: JNK ), and an investment-grade corporate bond ETF, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA: LQD ). Later, Seeking Alpha author Sajit Kapurvalapil wrote an article entitled ” Why Fallen Angels Fly Above Ordinary Junk ” that enumerated several years why fallen angel bonds might be expected to outperform regular junk bonds. A summary of this thesis is presented below (emphasis mine), interested readers are encouraged to read Sajit’s full article linked above. 1. Discount to Par Fallen angels are by definition required to trade at discount to face value, this is because any bond that was issued at investment grade yield can reach the higher yields of non-investment grade bonds only by trading far below its face value… This gap in market-to-par value between two types of comparably yielding bonds is why fallen angels are able to deliver higher risk-adjusted returns . 2. Higher Upside All else being equal, a bond that trades significantly below par obviously has an upside potential that is absent in a bond that trades close to par. 3. Lower Downside In theory, the two debt security types of identical credit rating suffer similar risks of default – although in reality t he issuers of fallen angels are usually larger established companies , while ordinary junk bond issuers are usually newer, more speculative enterprises. Sajit also presents data showing that over 1985-2014, fallen angel bonds showed a slightly lower average 12-month default rate (3.61%) compared to original-issue speculative grade bonds (4.54%). Fallen angels flying steady amid high-yield turbulence Recent turmoil in the high-yield credit markets, due in no small part to the commodities crash, has sent many junk bond ETFs and CEFs sliding. However, fallen angels have been able to fly relatively steady amid the turbulence in the high-yield sector. As can be seen from the chart below, ANGL has shown a year-to-date [YTD] total return of -1.76%, just under the investment-grade corporate bond ETF LQD at -1.42%. However, both junk bond ETFs have suffered, with HYG and JNK falling by -5.15% and -7.32% respectively. An actively-managed high-yield ETF, the AdvisorShares Peritus High Yield ETF (NYSEARCA: HYLD ) has performed the worst with a total return YTD performance of -14.2%. ANGL Total Return Price data by YCharts It can also be seen from the above chart that ANGL had actually outperformed both investment-grade and junk corporate bond ETFs for most of this year, and it only dipped below LQD in December. Differing credit profiles What could account for the disparate performance between ANGL and the other three junk bond ETFs, given that all four ETFs all hold only non-investment-grade debt? I believe that a large part of this discrepancy could be due to the different credit profiles exhibited by these funds, as shown in the graph below. (NB. “CCC or lower” includes unrated bonds). As can be seen from the chart above, ANGL has the majority (75%) of its assets in BB-rated bonds, which are the highest rungs of the non-investment-grade ladder. JNK is slightly “junkier” than HYG, while HYLD, the junkiest of the ETFs, has its highest allocation (79%) towards B rated bonds. ANGL also has the lowest proportion of its holdings allocated towards “CCC or lower” bonds at 7.6%, while JNK’s is the highest at 15.7%. Junkier junk underperforms At this point, the reader may be wondering, “BB and B are just one credit grade away from each other, how big of an effect does that even have?” The answer: a lot. As the graph below shows, U.S. high-yield BB-rated debt has done much better (-1.15% total return) than B-rated debt (-5.09%) this year. This is consistent with the YTD outperformance of ANGL (-1.76%), which holds mostly BB-rated debt, compared to HYG (-5.15%), JNK (-7.32%) and HYLD (-14.2%), which hold much higher allocations of B-rated debt. US Corp BBB Total Return Index Value data by YCharts Moreover, CCC-rated debt has absolutely tanked (-15.0%) this year, but with ANGL holding the least among of CCC or lower debt, it has been relatively insulated from the turmoil in the junkier sections of junk debt, at least for now. Interestingly, the graph above shows that BB-rated debt has actually slightly outperformed BBB-rated debt (which is investment-grade) this year, despite the worries that have engulfed the high-yield sector recently. Rising yields The difference in credit profiles could also account for the difference in yields between the four high-yield ETFs. ANGL, the highest quality junk bond ETF, as the lowest trailing-twelve-months [ttm] yield of 5.25%, while HYG’s is slightly higher at 5.73%. JNK has a ttm yield of 6.32%. HYLD, the junkiest ETF, has a whopping 10.87% ttm yield. (Source: Morningstar ). As can be seen from the graph below, however, the yields of the four junk bond ETFs have all risen higher since mid-year. This can be easily understood on the basis of the falling share prices of the ETFs this year. For example, HYLD, whose share price decreased by -14.2% YTD, has seen its yield increase by around 10% since the start of the year. The yields of various credit segments is shown below. As expected, the lower the quality of the bond, the higher the yield. US Corporate BBB Effective Yield data by YCharts The graph above shows that the yields of lower-ranked bonds have risen more quickly than higher-quality bonds. This can be more easily visualized by plotting the percentage change in yield of the various credit segments. US Corporate BBB Effective Yield data by YCharts The chart above shows that the yields for CCC or below bonds have risen by 62% since the start of this year. BB and B are close together at 26% and 28% respectively, while BBB bonds have risen the least, at 17%. If you must junk, go for the best junk The data presented above demonstrates that there is a significant difference between higher-quality and lower-quality junk. I believe that BB-rated debt, as the highest-rated credit segment within the non-investment-grade universe, occupies a “sweet spot” that allows it generate significantly higher yields than the investment-grade bonds just above it, while being significantly safer than the lower-rated debt below it. Indeed, BB debt has outperformed all credit classes within a range of both two notches above and below it since 1997, a period of nearly 20 years. The total return of BB debt over this period is 264.4%, followed by BBB (investment-grade) at 227.7%. A-rated debt ranks third at 197.1%, followed closely by CCC at 196.2%. B has done the worst at 178.1%. The implications for investors, I believe, are clear: do not be seduced by the higher yields of lower-rated debt – whether it be held as individual bonds, or wrapped up in ETFs, CEFs, or mutual funds – as these may not necessarily lead to higher total returns. I believe that ANGL is an excellent choice for accessing the sweet spot of BB-rated debt, that possesses the additional beneficial quality of being investment-grade when issued. ANGL also compares favorably to its peers with regards to expense ratio, and I am entirely happy with sacrificing 50 to 100 basis points of yield (compared to HYG and JNK) for an increased element of safety. ANGL: Expense ratio: 0.40%, ttm yield: 5.25%, ytd return: -1.76%, SA followers: 76. HYG: Expense ratio: 0.50%, ttm yield: 5.73%, ytd return: -5.15%, SA followers: 16,732. JNK: Expense ratio: 0.40%, ttm yield: 6.32%, ytd return: -7.32%, SA followers: 10,122. HYLD: Expense ratio: 1.23%, ttm yield: 10.32%, ytd return: -14.2%, SA followers: 2,096. When I wrote my first article on ANGL in Jun. 2015, the ticker had 76 followers on Seeking Alpha. Six months later, ANGL still only has 76 followers! (Its assets have increased from $36.7M to $53.6M during this time according to Morningstar.) Given its significant outperformance compared to the other three much more popular junk bond funds described above, I believe that this Morningstar 5 star-rated ETF deserves significantly more attention from the investing community. The total returns of the four junk-bond ETFs since the inception of the newest ETF, ANGL, is presented below. ANGL Total Return Price data by YCharts Scalper1 News
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